Decision by Glazebrook, Randerson and Stevens JJ in:

Russell v Commissioner of Inland Revenue [2012] NZCA 128, 3 April 2012

Legislation cited:

Income Tax Act 1976, ss 25(2), 99, 99(4), 191

Income Tax Act 1994, ss BG 1, GB 1,OB1, sub-pt G

Background

The taxpayer was assessed for income tax for the years 1985 to 2000 (with accumulated penalties and interest the amount claimed by the CIR currently stands in excess of $177 million).

The CIR contended that the taxpayer was a party to tax avoidance arrangements. The taxpayer disputed the assessments.

The CIR’s position was upheld by the Taxation Review Authority, Case Z19 (2009) 24 NZTC 14,217 and on appeal by the High Court, Russell v Commissioner of Inland Revenue (No 2) (2010) 24 NZTC 24,463.  

Appeal Grounds

The taxpayer appealed. The notice of appeal stated the grounds of appeal were that the High Court (Wylie J) was wrong to find that:

 (i) there was an “arrangement” as alleged by the CIR
(ii) the alleged arrangement was a tax avoidance arrangement
(iii) the taxpayer was affected by the alleged arrangement
(iv) the taxpayer obtained a tax advantage from the alleged arrangement.

Five Additional Grounds

Five additional grounds of appeal were raised by the taxpayer in his submissions.

(a) the majority of the assessments were time barred, ITA 1976, s 25(2)
(b) the ingredients of tax avoidance had not been met, Peterson v Commissioner of Inland Revenue [2005] UKPC 4
(c) the requirement inferred in s 99 of the ITA 1976 (particularised in the CIR’s policy statement) had not been met
(d) the assessment process was incomplete, s 99(4) had been ignored 
(e) the assessments were a product of an alleged longstanding vendetta practised by the CIR against the taxpayer.

The Court of Appeal only granted leave with respect to (d).

The Role of Russell Template Transactions

The taxpayer was assessed with the income of a partnership he controlled (the CM Partnership arrangement). The CIR contended that the by using this partnership the taxpayer avoided paying tax on the income earned through the Russell template transactions.

The taxpayer did declare a total income of over $298,000 for the tax years 1985 to 2000 inclusive. However, the CIR contended that the income that the taxpayer should have declared was in excess of $15 million.

The CM partnership (which had two partners both of whom were controlled by the taxpayer) was involved in a tax avoidance arrangement. That arrangement was based on a template.

The Arrangement

Under the template arrangement, the partnership would receive consultancy fees from trading companies in the template group. Income of companies in the group would be set off against losses of loss companies in the group.

Loss companies

The loss companies were acquired by the taxpayer when insolvent, and after obtaining control, the taxpayer purported to trade the insolvent companies under agency and management agreements. The taxpayer's personal exertion income was treated as income of the partnership income and diverted to the loss companies under the agency and management agreements.

Role of the tax payer

Surpluses or net profits from those untaxed monies were forwarded daily from that partnership to the group finance companies. All entities were controlled by the taxpayer, who directed the use of those funds. The finance companies acted as bankers to the taxpayer's template group of companies and other entities; and all cash in the group was used at the taxpayer's direction, including the business income of the partnership.

On a yearly basis, there were changes to the companies which made up the partnership, and the loss companies were replaced when losses were extinguished. The arrangement continued when the business of the partnership was taken over on 1 April 1997.

 What the High Court Held

The High Court held that there was one overall arrangement put in place by the taxpayer over the years from 1985 to 2000 which comprised a convoluted series of interlocking contracts, agreements, understanding and plans. Ultimately the income was diverted into companies that had losses and those losses were utilised to avoid the payment of income tax on the income.

Effect of the Arrangement

The Court considered the most relevant factor was that the taxpayer controlled everything. The effect of the arrangement was that it altered the incidence of income tax.

It ensured that the taxpayer’s income, earned from his personal exertions was diverted into a series of partnerships and companies controlled by him, no tax was paid on that income and the taxpayer retained control and could direct how the untaxed monies were used.

The High Court found that the purpose or effect of the tax avoidance was not merely incidental but rather it was contrived and had not only the effect of altering the incidence of income tax but that was its primary purpose.

Pretence

The arrangement also involved pretence as the taxpayer was tapping into the losses in the loss companies to avoid paying tax on his personal exertion income. The unrestricted transfer of profits to loss companies in the group bypassed the company grouping rules and significantly undermined the tax base.

Confirmation of TRA finding

The High Court further confirmed the TRA’s finding that the steps taken by the taxpayer were not within the purpose or contemplation of Parliament. The unrestricted transfer of profits to loss companies in the group bypassed the company grouping rules and significantly undermined the tax base. 

Although not directly receiving any of the income generated by the arrangement, the taxpayer was affected by it as he obtained a tax advantage because he did not pay tax on the income he would have earned but for the arrangement.

The Decision:

(1) The taxpayer’s appeal was dismissed.

(a) The scope of the arrangement

The taxpayer’s contention that none of the essential ingredients were present for an “arrangement” to exist was rejected. The High Court’s reasoning on this issue was correct.

There was an arrangement as defined in sOB1 of the ITA 1994. The arrangement was far broader in scope than the limited form of arrangement which the taxpayer conceded in the High Court (there was a tax avoidance arrangement between the partner companies of the CM Partnership and the loss companies).

The taxpayer put in place one overall arrangement that operated over the years 1985 to 2000. There was an overall plan conceived by the taxpayer and implemented by him through the various formal agency and management agreements and declarations of trust. The overall plan had “the taxpayer’s fingerprints on it at every turn”.

Consensus, plan & arrangement

Also agreeing with the High Court, that if consensus was needed, then the taxpayer provided any necessary consensus for the purposes of the overall plan. The taxpayer orchestrated the whole arrangement.

However the statutory definition of “arrangement” does not require such consensus, a plan will suffice. The overall plan was created, designed and executed by the taxpayer. It was noted that arrangement includes “all steps and transactions by which it is carried into effect” – again no consensus is needed.

(b) A tax avoidance arrangement

The taxpayer’s contention that the High Court was wrong to conclude that the overall arrangement had the effect of altering the incidence of income tax was rejected.

The overall arrangement established and operated by the taxpayer had the purpose or effect of tax avoidance as interpreted by the Supreme Court in Ben Nevis Forestry Ventures v Commissioner of Inland Revenue [2008] NZSC 115.

The arrangement was overarching in nature, rather than dealing with a number of discrete transactions. The transactions and structure established by the taxpayer was designed to receive income obtained from the Russell template arrangements and to ensure that the income from setting up and running those template arrangements was in turn sheltered from tax. These arrangements were in many respects similar to those arrangements held to be tax avoidance arrangements in the template cases and were therefore clearly tax avoidance.

Agreement with TRA & High Court

Agreeing with both the TRA and the High Court, the steps taken by the taxpayer were not within the purpose or contemplation of Parliament when it enacted the loss offset provision contained in s 191 of the ITA 1976. The unlimited transfer of the losses through the agency and management agreements was artificial and contrived,  having the effect of eroding the tax base by bypassing the grouping rules.

(c) A person affected by the arrangement and obtaining a tax advantage

(i) The taxpayer’s argument that he was not affected by the arrangement was rejected.
The taxpayer was a person affected by the arrangement, he was a party to it and was directly affected by it, that was evidenced by the taxpayer controlling all the entitles involved (particularly through the business consultancy agreements) and the untaxed funds generated by the CM Partnership were paid to the finance companies controlled by the taxpayer. From those funds advances were made to the taxpayer that enabled him to meet his personal obligations and further advances were made to various trusts the taxpayer had settled for the benefit of his family. The taxpayer effectively controlled the untaxed money generated by the arrangement.

(ii) The taxpayer was the only real person underpinning the whole arrangement.
The transactions did not happen by accident and the taxpayer was affected by it.

(iii) The taxpayer obtained a tax advantage from the arrangement which was more than merely incidental.
He did not pay tax on any income derived from the Russell template transactions. Although the CM Partnership was carried on by means of various partnership and corporate entities they also did not pay any tax resulting from the artificial introduction by the taxpayer of the various loss companies alongside the partners so as to off set the net profits earned by the CM Partnership.

(iv) While accepting the High Court finding that the tax avoidance was not merely incidental to the arrangement the Court differed in its reasoning from Wylie J in respect of his reliance on the notion that monies resulting from the CM Partnership business ought to be characterised as “personal exertion income”. That description did not necessarily assist the analysis. Rather it was preferred to rest the conclusion as to the purpose of the overall arrangement and the tax advantage derived from it on a broader basis. The overall scheme was the means by which the taxpayer laundered the profit on the Russell template transactions and other related income without paying any tax.

(d) Reconstruction to the taxpayer

(i) It was correct that the income should be attributed to the taxpayer.
The Court noted that central to the taxpayer’s submissions was that what occurred through the overall arrangement was not tax avoidance because he had not received,  in any form,  any of the income that had been assessed to him.

The taxpayer contended that it was permissible  to carry on the consultancy business through a partnership and corporate entities, as it was they, and not him personally, that received the income. Therefore the CIR was not correct to reconstruct the income to him personally.

This contention was rejected as the CIR has broad powers of reconstruction under s 99(3), Miller v Commissioner of Inland Revenue [1999] 1 NZLR 275 (CA) applied.

Onus on the taxpayer

The onus was on the taxpayer to establish that the reconstruction was wrong and by how much, Buckley & Young v  Commissioner of Inland Revenue [1978] 2 NZLR 485 (CA) applied. The taxpayer did not satisfy that onus.

Throughout the period 1985 to 2000 the taxpayer manipulated the partnership, corporate, finance company and trust entities as he saw fit.  He saw to it that he received only nominal income for the provision of consulting services and placed sums which flowed into the CM Partnership on deposit with one of the finance companies he controlled.

Laundering through CM Partnership

What the taxpayer did was more than just income allocation for genuine business reasons.  He sought to launder through the CM Partnership , and the other entities controlled by him, the whole of the substantial income from the Russell template system, itself a clear tax avoidance scheme, which had dramatic financial consequences (no tax being paid by the taxpayer or the partners in the CM Partnership or the partnership over a 15 year period)

(ii) The Court differed from Wylie J’s reasoning that the decisive factor was that the taxpayer was diverting into the CM Partnership the income generated from his personal exertions stating that this ought not to be characterised as income earned by the taxpayer personally. It was income earned by the CM Partnership and other entities within the structure set up by the taxpayer utilising the staff employed by those entities.

(iii) The income was attributable to the taxpayer because he was affected by the arrangement on a Penny basis (Penny v Commissioner of Inland Revenue [2011] NZSC 95) and because he was the governing mind of the template arrangements as well as the other structures and arrangements designed to shelter from tax the income earned from the template arrangements in the Russell group of companies.

(e) The assessment process was incomplete, s 99(4) of the ITA 1976

The taxpayer’s contention that the effect of s 99(4) is “instantaneous and automatic” did not succeed.

The CIR is not required to make an adjustment as soon as any income is included in the assessable income of any person because that income is deemed by s 99(4) to be derived by the person assessed and “shall be deemed not to have been derived by any other person". 

Assuming any part of an assessment made by the CIR in respect of the taxpayer included some income deemed by s 99(4) to be the income of someone else the assessment is not void as it is open to the CIR or the TRA to remedy the position at a later point. It is for the CIR to remedy the position if persuaded that there was a genuine inconsistency in the assessments and it was for the taxpayer to establish the true position and bring any inconsistency to the notice of the CIR.

The CIR could remedy the inconsistent assessment by making the amendment at any time before the objection proceedings had run their course.
Even if the Court was wrong on this point, the Court stated that it would not render the assessments against the taxpayer void.
It is for the CIR or the TRA to make any necessary amendment to remedy the inconsistent assessments.

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